Many teachers have 403(b) employer retirement plans, which have saving and tax-deferral rules similar to 401(k)s. Contributions from salary deductions lower taxable income, then grow tax-deferred until withdrawn in retirement. Employers may offer Roth 403(b)s, which do not provide a tax break now, but instead offer tax-free withdrawals in retirement. Some employers match contributions, often after a minimum period of employment. Plans may allow participants to take loans or hardship withdrawals before retirement, subject to certain limitations.
But 403(b) plans for school teachers often limit their offerings to insurance products, and may charge substantially higher fees than 401(k)s. The retirement market for education workers has historically involved pensions and retirement income guarantees – which explains why products from insurance companies are prevalent. The SEC notes that some states even prevent school districts from limiting the companies that can sell 403(b) plan investments, and warns participants that your employer may not have done screening of any investment product, firm or professional that sells 403(b) investments.
Plan participants may have no idea what they’re buying. It’s possible a variable annuity contract within a 403(b) could appear like signing up to invest in mutual funds, though with little understanding of the actual fee structure. In addition to the investment management expense, variable annuities common in 403(b) plans may have annual maintenance fees, mortality and expense risk charges, surrender charges and fees for special features like enhanced death benefits. I recently helped a family friend review his retirement plan enrollment kit for a new teaching job. His plan featured investment options with average expense ratios close to 1.00%, a $30 per year service fee and a 1.75% mortality and expense fee.
All of these charges reduce the value of the account and the return on investment. An investment with high costs must perform better than a low-cost investment in order to produce the same net returns for you. Even small differences in costs can result in large cumulative differences when compounded over time.
While the conventional wisdom suggests one should enroll and start contributing as soon as possible to save for retirement, there are other options to consider in place of or to complement a 403(b) if low-cost providers are not available. These options could include a Traditional IRA or Roth IRA, fully funding a spouse’s retirement plan if his or her options are better, or non-retirement accounts invested tax-efficiently. Be aware that some financial professionals will offer only limited strategies.
The best advice is to ask questions and make sure you understand the choices and fees before committing a portion of your salary. Some plans have high fees and limited flexibility, while others are user-friendly, offer personalized help and a platform of well-regarded diversified investments. If you are paying extra for annuity features, find out what you are getting in return.
For more education and help with questions or complaints, see the U.S. Securities and Exchange Commission page on retirement options for school employees: https://www.sec.gov/investor/pubs/teacheroptions.htm